Capital One Earnings: Higher Credit Losses and Funding Costs Pressure Bottom Line Results

Narrow-moat-rated Capital One COF reported results that were roughly in line with our expectations as higher credit costs and narrower net interest margins pressured bottom line results, partially offset by good expense management. Net revenue increased 9% from last year and 1% from last quarter to $9 billion. Diluted earnings per share decreased 29% from last year to $3.52, which translates to a return on tangible common equity of 15.3%. The decrease in earnings was primarily due to higher credit costs as Capital One built up another $328 million in reserves, while 2022 was a year of unusually low net charge-offs industry wide. As we incorporate these results, we do not plan to materially alter our $140 fair value estimate for Capital One and we see the shares as undervalued at current prices.

Capital One’s net interest income increased 9% year over year but decreased 1% to $7.1 billion. The annual increase in net interest income can be entirely attributed to credit card loan growth. Credit card receivables grew 18% from last year while auto loans and commercial loans decreased 5% and 3%, respectively. We expect credit card loan growth to continue to outpace the bank’s other segments in the near term as Capital One has pulled back on its auto and commercial lending. This increased focus on its higher-yielding card business will be a tailwind to its net interest margin but will come at the cost of higher credit costs.

Despite this tailwind, Capital One’s net interest margin decreased again during the second quarter, falling to 6.48% from 6.54% last year and 6.60% last quarter. Net interest margins for credit card issuers have come under pressure across our coverage as competition for deposits has pushed online deposit rates up faster than asset yields, with Capital One being no exception. This pressure will likely remain in the coming quarters as we are in the later stages of the current interest rate cycle and the bank’s net interest income growth will face headwinds.